Wednesday, 11 March 2015

Will the new RBI rules on bank loans prove to be a lender bender?

In a month from now, the rules of the game will change. Banks will be forced to treat ‘restructured’ loans as ‘problem’ loans.

Like many things that happen only in India, for years Indian banks have been following a practice that lenders in other countries don't. They rejig loans of troubled borrowers — charging them lower interest, allowing them a longer repayment time — to save the loan from turning bad and protect the bank bottomline.The beauty of the arrangement is that banks have to provide very little — meaning, they have to set aside a smaller amount — for such "restructured loans" as compared to the much higher provisioning specified for bad loans, better known as non-performing assets, or NPAs.After April, banks can no longer resort to this comfortable book-keeping. Since there will be no difference between NPAs and restructured assets, banks will have to set aside 15% of restructured loans as provisions as against 5% they do now.

The annoyance among bankers, who have been under the spotlight for mounting bad loans, is understandable: higher provisioning means lower earnings; and, the quality of their loan book will look worse than what appears now. The fear is that if growth fails to take off, there won't be too many other earning avenues to make up for the loss.

THE GENESISThe new rule owes its origin to reforms that followed Manmohan Singh's first budget. On April 27, 1992, the Reserve Bank of India (RBI) asked banks to treat all restructured loans as problem loans, thus attracting higher provisions. The idea, back then, was to be in line with international best practices.

A decade later, when large financial institutions like ICICI and IDBI were planning to become banks, these lenders lobbied for a change. They argued that many projects were stuck due to external factors like delays in clearance from various state and central authorities and even promoters who were willing to service loans were unable to pay as cash generation had been delayed by time and cost overruns.

Around the same time, environmental issues in special economic zones had cropped up and land acquisition for several projects hit a roadblock. Faced with these ground realities, RBI agreed to change the norm. According to the revised rule, restructured norms were no longer classified as problem loans. In one shot, provisions on such loans fell to 2% from 10% (that applied to NPAs then). RBI coined a new basket for such loans: "restructured standard assets".

POSTPONING THE PROBLEMThe rule relaxation, however, came with some guidance. "Banks," the new rules said, "can undertake restructuring if in their opinion the bottleneck in achieving regular commercial production was of temporary nature, not indicative of any long-term impairment of the unit's economic viability and if the unit was likely to achieve cash break-even if some time was allowed."

Soon many banks, desperate to show improved balance sheets, began to ignore the advice. Between March 2002 and 2013, banks' loan book grew by 779% to Rs 59,89,182 crore while the portfolio of restructured loans grew by 3,087% to Rs 3,13,003 crore.

Analysts say a predominant number of loans were restructured without looking into merit. Due diligence was slack and often project viability was not scrutinised. Indeed, RBI, in its annual inspection of banks, observed "banks lacked clarity" while restructuring advances. The regulator feared 25-30% of the restructuring would fail to turn around. Questions were raised in RBI on whether banks had the cushion to absorb the shock if some of loans sank.

When the share of restructured loans overtook that of problem loans, RBI stepped in. Addressing the media, RBI governor Raghuram Rajan recently said, "It's important we clean up bank balance sheets and show what they actually contain. That will enhance confidence in bank balance sheets and enable banks to raise the much needed fresh capital. In order to build confidence in bank balance sheets, we have to come to an end of forbearance... It is to call a spade a spade."

It was an open secret that many loans were restructured simply to postpone the problem. Troubled promoters with high leverage and ambitious projects were given a long rope. By chipping in as little as 2% of restructured debt as extra equity from promoters, these borrowers bagged concessions on interest rates and one to two years of repayment holiday.

In 2013, RBI brought back the old rule of the '90s. It spelt out that the moment a loan was restructured it should be treated as a problem loan with higher provisioning. Banks were given two years' time to migrate to a stricter loan classification and accounting rule, though the rule was not applied uniformly for all loans.

A special dispensation was thrown in for new promoters, infrastructure and certain non-infrastructure projects (excluding services and real estate); if the projects were not completed within the timeframe envisaged in the agreement, the restructured loans for entities within these categories could be treated as a performing asset for six months, two years and one year respectively.